The financial consequences of lean
Why is it so hard to see the financial consequences of lean? The lack of an answer to this dilemma has hindered many lean initiatives. It does not become a big problem if senior management truly understands the meaning of focusing on creating a flow in which everything works right the first time and arrives at the right time for customers. Like the senior management of Toyota and Tesco, they know that good processes lead to good results. Alternatively, if you have an experienced sensei who knows where the gold is buried and has worked in similar situations before, there is a good chance they can help you achieve the kinds of results you expect from lean.
But, in my experience, help is needed if you are pioneering lean in your organization while, at the same time, trying to convince senior management that it is possible to produce lasting financial results. This is particularly true when you are dealing with a complex, shared supply line, with several stages and routings through which different products or services flow. It becomes much more complex to see where to act to deliver the greatest gains for the organization and for customers. And as my colleague John Darlington has shown, traditional accounting systems and even sophisticated product costing systems end up rewarding the wrong kinds of actions.
As John says, they encourage overproduction by valuing what was made rather than what was sold, and they fail to recognize the importance of constraints; they encourage point optimization instead of flow; they have nothing to say about lead time; they promote the idea that large batches lower unit cost; and they encourage cost reductions that often prove to be illusions. In other words, they fail because they do not show the power of focusing on reducing lead time, which is the heart of lean.
Unlike Financial Accounting, which reports results to the outside world, we are free to choose how to build our internal costing system in order to drive the right kinds of actions. For example, lean organizations use Target Costing systems to focus improvement efforts in new product development. Why don't we do something similar to design and improve end-to-end process paths, or value streams - particularly where they involve shared resources and cross several departments?
John shows how to add operating costs to the value stream maps for all the products that pass through these shared resources, and how translating inventories into time gives us the basis for Flow Costing, which reports the time products take to move through the value stream (instead of the cycle time through each operation) to show the costs of the operation. Inventories (and delays in services) are the richest source of insight into how well we are using our capacity to generate cash through sales. Short throughput times increase the ability to respond to quality problems and to introduce engineering changes; they can grow margins and postpone the need for new investment, meeting deadlines with less inventory and finished goods.
The real value of Flow Costing is to help set the priorities for lean improvements, by making it possible to see the financial consequences in terms of increased sales, less cash tied up in inventory, reduced operating expenses and deferred investments. These properties can then be built into the policy deployment objectives of each department and the resources in their budgets to achieve them. Flow Costing is a powerful way to help bring lead times much closer to value-adding times, at which point the differences between Flow and Product costing systems almost disappear.
Daniel T Jones
Chairman, Lean Enterprise Academy.
